Consumer price index is a big lie

The U.S. consumer price index continues to be a testament to the art of economic spin.

Because wages, Social Security cost-of-living increases and some agency budgets are tied to it, the government has a vested interest in keeping it as low as possible.

Yet your real cost of living — what you keep after taxes, medical bills, college expenses and other household costs — is probably much higher than the 2 percent annual rate the government reported in July, showing a slight decline.

And there’s also a goliath looming in the U.S. economy that makes the government’s consumer gauge more deceptive. Even with the stinging reality that housing values are dropping in many markets, homeownership costs such as taxes, maintenance and financing are still rising much faster than the index.

The half-point cut in the Federal Reserve’s target rate Sept. 18 — to 4.75 percent — will do little to shield more than 2 million homeowners from foreclosure for adjustable-rate mortgages that are resetting to monthly payments people can’t afford.

The recently expired U.S. housing boom is continuing to strain household budgets, though little of this home-related inflation is measured by the consumer index.

Rising home values forced up assessments for property taxes, which are slow to fall when the housing market recedes. Since these levies are based on rising home values for last year, few will see relief in 2007.

Gerald Prante, an economist with the Washington-based Tax Foundation, found that median real-estate taxes on owner-occupied housing went from $1,614 in 2005 to $1,742 last year.

“That’s an increase of 7.93 percent, more than double the inflation rate in that time period,” Prante says.

Those tax levels may sound like nirvana to a New Jersey resident, where median levies are almost $6,000. Vermont, Illinois, Rhode Island, Massachusetts, New York, Connecticut and New Hampshire all have rates that are more than $3,000, with many upscale areas exceeding $15,000 per year.

The single-largest expense for most Americans is housing, accounting for as much as a third of household outlays. Yet the Labor Department’s Bureau of Labor Statistics only tracks “owner’s equivalent rent,” or what a home would yield if it was rented out. Rental units and homes are two very different animals, though, and the government casts a blind eye to total homeownership expenses.

Most critics of the CPI have had a field day with the index based on the unrealistic tracking of housing costs. The bureau, which compiles the index, has stated that it isn’t a complete cost-of-living index. The common and mistaken perception still persists that consumer inflation is represented in this measure.

Medical expenses are given short shrift as well. It wasn’t that long ago when employers could cover almost all of an employee’s health-care bills.

Now, workers are shelling out an average of $3,281 from their paychecks for family medical coverage, according to the Kaiser Family Foundation, a nonprofit organization based in Menlo Park, Calif. The average premium for a family policy is more than $12,000 annually.

Since 2001, health premiums have risen 78 percent while wages have only gained 19 percent. The government’s inflation measure during that stretch was 17 percent.

You are keeping pace with inflation if your income can cover losses in benefits or other household items costing more. If you are paid in bonuses and commissions, you can often close the gap in good years.

Salaries often fall short, though, because many raises are based solely on the consumer index.

What no government gauge can tally is a household’s net worth. This is all of your wealth — home equity, stocks, bonds, business capital, retirement plans — minus your debts.

Having a positive net worth is a step in the right direction. Yet most families don’t experience this sense of wealth until their children are out of college — another huge expense that has been climbing at triple the rate of the consumer index.

If you were counting on home equity to boost your net worth, the housing bust will certainly give you pause for reflection.

Are you in an area where home values are stable? That’s largely dependent on local employment and economic conditions. In a market glutted with homes that can’t sell, you have a reason to be concerned and shouldn’t depend entirely on selling your home at a future date to create a retirement fund.

Not relying upon home equity exclusively for your nest egg is smart financial planning.

One of the best ways to beat inflation is to own securities that hedge inflation risk and its many facets. Don’t go out shopping for energy, health-care and gold stocks, though.

Think long-term and diversify. Over the last 80 years, large- and small-company stocks have beaten an average inflation rate of 4.3 percent, according to Ibbotson Associates, a Chicago-based research firm owned by Morningstar Inc.

Small stocks, generally companies with market values of less than $1 billion, averaged almost 13 percent annually since 1926, with large firms returning about 10 percent.

Since these two asset classes are among the most volatile investments, you can’t expect those returns every year. During the Great Depression, small companies lost from 10 percent to 60 percent.

Make your inflation-beating strategy simple. Invest in index or exchange-traded funds through your 401(k) or retirement plans. Two big-basket vehicles include the Vanguard Total Stock Market VIPERs or its Small-Cap VIPERS.

When making goals for your portfolio returns, it’s wise to avoid using the government’s inflation rate as a benchmark. Aim higher. Shoot for outpacing your household’s cost-of-living increase. That’s the most important number to beat.

John F. Wasik, author of “The Merchant of Power,” is a Bloomberg News columnist.